Jim Rogers: Time to Buy Agricultural Commodities

“If you can tell me something else where the fundamentals are so attractive…I’d be happy to put my money there,” said Jim Rogers, the famed investor and self-made billionaire in a recent interview. “But I don’t know of any other place.”

What’s he talking about? Today, we take a look and invest right alongside his idea. And it should start to pay off with the arrival of the first swallows of spring in 2010. It’s also timely now — in this weak-kneed economy — because it has traditionally held up well even in when the economy is on the ropes. Even the Great Depression couldn’t put this thing down.

We start with simple truths. The world’s population has more than doubled since 1950 — from about 2.5 billion to 6.7 billion. By 2050, there will be more than 9 billion people on the planet. Almost all of this growth will come from undeveloped markets such as China and India. And they will all be doing one thing, for sure — eating.

Now, hang on. I know that is a banal insight by itself, but this story has layers like a tiramisu. The second layer is the mix of food eaten, which is important. These undeveloped economies are getting richer. Predictably, as people everywhere have done and continue to do when they have a little more money in their pockets, they change their diets. They spend more on food. The average Chinese spends 40 cents of every additional dollar earned on food. In India, it’s about 70 cents of every additional dollar. What do they buy?

They buy more meat, more fruits and more vegetables. Their calorie intake rises. That’s why the U.N. says we’ll need to boost food production by 70% by 2050 — a big task, given increasing restraints on water and quality arable land.

How do we meet that demand? Here the plotlines start to thicken and things get interesting…

Let’s look at soybeans specifically. China is the largest importer of soybeans and has been since 2000. China was once the largest exporter of soybeans, but flipped to a net importer in 1995. It may well be impossible for China to meet its demands for soybeans by producing more of its own. Passport Capital, an astute hedge fund, estimates that in order to grow enough soybeans to become self-sufficient, China would need to cultivate an area about the size of Nebraska.

That looks impossible against China’s arable land base, which has been in decline since 1988 — this despite the fact that China’s subsidizes agriculture. Another reason is the low level of water resources in China. Soybeans require a lot of water — 1,500 tonnes of water for one tonne of soybeans.

Who has lots of water? Brazil. So it is no surprise to discover that the increase in demand for soybeans from China has largely been met by increasing soybean acreage planted in Brazil. (Brazil is the second largest exporter of soybeans in the world, behind the U.S. and ahead of Argentina and Paraguay.)

The easiest way for China to get around its water shortage is to import soybeans. By importing soybeans, Passport calculates that China is effectively importing 14% of its water needs.

It looks likes this trend will continue for quite some time. When you look across the world, arable land per person is in decline. (Arable land simply means land that can be used for farming; it doesn’t mean that it is currently used for farming.) But one nation has more potential for converting arable land into producing farmland than anybody else by a country mile. It’s Brazil again.

Brazil has a large tropical savanna known as the cerrado. You can think of it as the world’s arable land bank. It’s an area of about 250 million acres — about as big an area as all of the arable land in the U.S. It gets plenty of rainfall and sunshine. The soil is very old and runs deep. But there is a problem: The soil is nutrient poor. You need to add a lot of potash and phosphate — two key nutrients — to grow soybeans there.

According to estimates by SLC Agricola and Morgan Stanley, the average new acre of farmland in the cerrado requires 14 times the amount of phosphate and three times the amount of potash of a typical American acre. This means that it is expensive to grow grains here. You need a high soybean price to make it worth the effort — and there is more to it than just adding the nutrients. There is road and rail access, for instance. Someone would have to build all that out, too.

Connecting the Dots — Grains Are Cheap

So now we are in a position to connect some dots. China’s increasing population and affluence will drive its soybean imports. These imports will come mainly from Brazil. And Brazil, as it converts more arable land to producing farmland, will need a lot of potash and phosphate.

What is true of soybeans is also true of wheat and corn and rice and other agricultural commodities. We’ll need more of all of them. And all of them face the same challenges for water and land. All of them require lots of fertilizer.

I’ve not mentioned the biofuel component. But this is another big pull on demand for grains. The U.S. alone aims to produce 15 billion gallons of ethanol by 2015. All over the world, food crops now compete with energy needs.

This is not a gloom-and-doom scenario. It simply means that there is a lot of support for higher prices for agricultural commodities. Inventory levels still remain low worldwide. Grain prices are all well off their highs. After adjusting for inflation, many of them are as cheap as they’ve been in decades.

This is why Jim Rogers said he likes the agricultural commodities. That’s what he was talking about in the quote up top. I couldn’t agree more.

I also mentioned how this idea was hard to kill. In the Great Depression, purchases for jewelry and clothing and the like fell by 50%. But purchases for food — even for meat — held steady. We’ve seen similar patterns in recent busts. In the Asian Crisis of 1998–2001, the demand for food held steady even while other markets collapsed.

Put it all together and you have a great case for higher grain prices. You also have an environment that is very good for fertilizers — in particular, potash and phosphate. An investment in the fertilizer stocks is an investment right alongside the grains.

I’ve just alerted my Capital & Crisis readers to two fertilizer stocks that I believe are best positioned to profit from the coming agricultural commodity boom, but there are a number of fertilizer plays out there that are also ripe for the picking.

A couple worth taking a look at include Agrium (NYSE: AGU) and Western Potash (TSE: WPX). Naturally, I’m partial to the ones that I’ve recommended to my C&C readers – and they’ve got pages of research to back up why that is – but these two tiny stocks could make interesting moves nonetheless.

Comments

Are there other ways through equities to participate in commodities, such as for example companies in Brazil that produce soybeans?

After my experience with the etf's USO and USL, which captured less than half of oil's 80% rise in spot price, I'm wary of going that route with agricultural commodities, and would rather find equities that participate. For example, most of the oil companies I held (cloning picks from R.Rodriguez, Pickens, and others), did do quite well.

You could try one of the funds that are based on Rogers' various commodity indexes. I think there is one dedicated to agricultural commodities. Of course there is the possibility that some part of the "investment" that Rogers claims to have in commodities consists of his profits that are generated by managing and licensing those indexes.

Fk: "After my experience with the etf's USO and USL, which captured less than half of oil's 80% rise in spot price, I'm wary of going that route with agricultural commodities, and would rather find equities that participate."

LwC: "You could try one of the funds that are based on Rogers' various commodity indexes. I think there is one dedicated to agricultural commodities."

Rogers' commodity indexes, which appear to be better than competitors, are just as vulnerable to the USO/USL problem that Fk is referring to. The problem is that commodity indexes invest in futures contracts which they need to continuously roll over. If the commodity market is in contango, as crude oil was late last year to early this year, you will get killed every time the contract rolls. You could be losing 4% per month, which means you lose around 20% in 5 months alone.

If you are superbullish then the theoretical loss may not matter. For instance, if you were investing in oil early this year and you expected it to rise 200% (say 50 to 150) then you may be able to tolerate 20% to 50% less in profits.

Also, if the futures curve goes into backwardation (the opposite of contango), you actually gain every time you roll the contract. So it can work in your favour too.

The only solution around this contango problem is for the fund to physically own the commodity (rather than owning futures contract that keeps expiring.) As far as I know, only the 2 gold and 1 silver ETF own the underlying physical asset. All the others don't and may never (it's hard to imagine someone storing perishable agriculatural commodities for years.)

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